Interest rate rise prospect on inflation outlook

Inflation expectations have edged higher this month, piling pressure on the
Bank of England to raise interest rates.

Interest rate rise prospect on inflation outlookPhoto: ALAMY

By Philip Aldrick, Economics Editor

6:12AM BST 28 Oct 2010

According to a Citi and YouGov public poll, expectations for inflation over the coming year currently stand at 3pc, compared with 2.9pc in September.

"Inflation expectations for the year ahead have not been higher since September 2008," Citi economist Michael Saunders said. Inflation was then running at 5.2pc – a 16-year high – compared with 3.1pc currently.

Policymakers are concerned that rising inflation expectations could become self-fulfilling by working through to prices and wage settlements. Mervyn King, Governor of the Bank of England, has previously warned: "If that were to occur, it would be costly to bring inflation down."

Interest rates would have to rise, potentially crippling the recovery which is reliant on a loose monetary policy offsetting the spending cuts and tax rises. Most economists expect interest rates to stay low at least until the second half of next year, and many think the Bank will restart quantitative easing with an additional £50bn.

"The uptick in long-term inflation expectations... may well reflect actual inflation data, with UK inflation well above target and well above [Bank] forecasts," Mr Saunders said.

To date, though, there is little evidence that higher inflation expectations are becoming embedded. Most pay deals were worth between 2pc and 3pc in recent months, below the rate of inflation, according to a study from Incomes Data Services published today.